1. Field of the Invention
The present invention relates generally to a system and method for multilateral net settlement, in which participants deposit a predetermined amount into a prefunded balance account and send messages to one another incurring obligations to pay. These obligations are netted against each other, giving each participant a net credit position or a net debit position that is settled at the end of the day. More specifically, the present invention relates to an improvement allowing participants to transfer supplemental funds into their prefunded balance account throughout the day, and, for example, is intended to be an improvement to the system and method for Intraday Netting Payment Finality described in U.S. Pat. No. 6,076,074, which is incorporated herein in its entirety by reference.
2. Related Art
A person (individual or corporate) making a payment in the United States has an array of payment instruments from which to choose. It is likely that most single transactions still are paid for in cash (coin and currency). There are also checks and other paper instruments (travelers' checks, money orders, and certified and cashier's checks) and debit and credit entries processed by automated clearing houses (“ACH”) (a computer-based, batch processing electronic payment mechanism that supports both credit and debit transfers and is used primarily for low-dollar transactions such as direct deposit of payroll and benefit payments and mortgage and insurance premium payments that can be scheduled some time in advance and that are not time-critical). The largest payments, however, usually are sent by funds transfers. Each day, the two principal funds transfer systems, Fedwire and CHIPS (“Clearing House Interbank Payments System”), transfer hundreds of thousands of payments worth more than $2 trillion. The average size of a funds transfer is very large—about $6 million on CHIPS and $3 million on Fedwire.
Funds transfers can involve a number of different parties. Many transfers take place to settle obligations of two banks, such as the delivery or return of “fed funds” (a bank's deposits with its Federal Reserve Bank, which can be lent to other banks). In these cases, only the two banks are involved. Banks also transfer funds on behalf of customers. These transfers may be to another person, either at the same bank or at another bank. Sometimes a customer moves funds between two of its own accounts, either at different banks or at the same bank, for example, from local accounts used to collect bills to a cash concentration account or to a payroll account.
A funds transfer may involve a single bank (a “book-transfer”) or it may involve several. In most cases, the originator does not specify the method for carrying out his payment order, and the originator's bank selects the most efficient way to have the funds sent to the beneficiary, including choosing a network or intermediary bank.
A. Origination of Funds Transfer
There are many ways for a person to order his bank to send a funds transfer. Probably the largest number of funds transfers, and certainly those involving the highest monetary value, are those originated by corporations with a direct computer-to-computer link to the bank. In these cases, the customer enters the payment instructions into his computer, and the computer sends the payment order directly to his bank's computer. The bank's computer “edits” the payment order. If the payment order fails one of the edits, for example, if mandatory information has not been included in the payment order, the computer routes the payment order to an operator's screen, and the operator makes any necessary corrections or seeks (or has someone else in the bank seek) clarification from the customer. A similar procedure is used for customers who use a personal computer to transmit payment orders to the bank. Individuals generally must go to the bank to fill out a form and pay a fee for a funds-transfer service.
B. Originator's Bank's Acceptance of Payment Order
Once the payment order has been entered into the bank's funds-transfer computer system and passes the initial edits, it is checked against the customer's demand account balance. If the balance is sufficient, the bank executes the payment order by issuing a corresponding payment order to a funds-transfer network or the next bank in the finds transfer. If the customer does not have a sufficient balance in his account, the computer checks to see if the customer has an available credit line. If so, the payment is released; if not, the payment is held pending receipt of funds to cover the payment. If covering finds have not been received by the late afternoon (usually 2:00 to 4:00 p.m.), the payment order may be referred to a credit officer who decides whether to extend additional credit to the customer to enable the payment to be made.
If a payment order has not been sent by the end of the execution date (the date that the bank may properly issue a payment order in execution of the sender's order), the bank normally rejects it by sending a notice of the rejection to the sender.
C. Transfers Between Banks
If there is more than one bank involved in a funds transfer, it is necessary for funds to be moved from one bank to the other. In the U.S., this can be accomplished by using one of the two large-dollar funds transfer networks to be discussed below, or through the adjustment of correspondent balances.
1. Fedwire
One of these transfer networks is “Fedwire”, which is the funds transfer network operated by the 12 Federal Reserve Banks. It is a real-time, gross settlement system, meaning that the payment is final and irrevocable at the time the Federal Reserve Bank credits the account on its books of the receiving bank. There is thus no risk that the receiving bank will suffer a loss if it makes the funds available to the beneficiary and the sender cannot pay the amount of the payment order to its Federal Reserve Bank. In such a case, the Federal Reserve Bank would suffer the loss, not the receiving bank. A payment order received by a Federal Reserve Bank is routed to a Fedwire processing computer. This computer performs system edits and routes the payment order to the receiving Federal Reserve Bank, which automatically credits the receiving bank's account and sends an advice to the receiving bank.
2. CHIPS
The other such transfer network, is the Clearing House Interbank Payments System (“CHIPS”), which is a funds-transfer system operated by The Clearing House Payments Company L.L.C. (“Clearing House”). A CHIPS participant (a “participant” is defined as a financial institution that may deliver and receive payment messages through CHIPS) that sends a CHIPS payment message to another participant incurs an obligation to pay the receiving participant the amount of the transfer. This obligation is settled in accordance with the system and method for intraday payment finality described in U.S. Pat. No. 6,076,074.
As an alternative to these funds-transfer networks, if a bank has a correspondent relationship with the bank holding the beneficiary's account, or if the bank does not have direct access to a funds-transfer network, it may use debits and credits to various correspondent accounts to complete a funds transfer. Often a bank sends a payment order over the network operated by the Society for Worldwide Interbank Financial Telecommunication (“SWIFT”), with payment of the sender's obligation effected through adjustment of correspondent balances or other means. Payment orders may also be sent by telex or other communications medium. The actual mechanics of performing these transactions varies from bank to bank.
In some cases, a customer may ask his bank to transfer funds from his account and pay another account on the books of the same bank (either another customer's account or a different account of the ordering customer). These are called book transfers because they take place on the books of a single bank. Procedures used to effect these transfers and recordkeeping arrangements vary from bank to bank. Example 5 in U.S. Pat. No. 6,076,074 shows the accounting entries for a book transfer.
D. Paying the Beneficiary
The last step in the process of a finds transfer is paying the beneficiary. In all but a small number of cases, this is accomplished when the beneficiary's bank credits the beneficiary's account on its books and allows the beneficiary use of the funds. Under Federal Reserve Board regulations, a bank must make the proceeds of a funds transfer available to the beneficiary no later than the opening of business on the day after the bank has received final payment. For Fedwire payments, final payment occurs when the amount of the payment order is credited to the receiving bank's account at the Federal Reserve Bank or when notice of the credit is sent, whichever occurs first. For CHIPS transfers, final payment occurs when settlement is completed. For transfers using a correspondent account in which the sender credits the account on its books of the receiving bank (Example 4 in U.S. Pat. No. 6,076,074), final payment occurs when the credit is withdrawn or, if it is not withdrawn, at midnight of the day on which the credit is withdrawable and the receiving bank learns of the fact. Where the receiving bank debits the senders account (Example 3 in U.S. Pat. No. 6,076,074), final payment occurs when the debit is made to the extent the debit is covered by a withdrawable credit in the account.
E. Interbank Settlements
Both of the above-mentioned major funds-transfer systems in the United States provide for settlement, i.e., the actual transfer of value in good funds that results in final payment. Once settlement is accomplished, payments are irrevocable (except in cases of duplicate or erroneous payments). The actual mechanics of the settlement in Fedwire and CHIPS differ, reflecting the differences between a real-time, gross settlement system operated by the central bank and a privately operated real-time final settlement system.
1. Fedwire
From the point of view of a bank that sends a payment order to or receives a payment order from a Federal Reserve Bank, Fedwire funds transfers are final when made. The sender's Federal Reserve Bank debits the sender's account as of the time the Federal Reserve Bank acts on the payment order. The receiving bank receives final payment when its Federal Reserve Bank credits its account or sends an advice of credit, whichever is earlier. At this point, the beneficiary has been paid, and the originator's obligation to pay the beneficiary is discharged. The receiving bank has good funds in its reserve or clearing account that can be withdrawn and that counts towards fulfillment of the bank's required reserve balance.
Viewed from the inside, however, Fedwire is a net settlement system involving 12 settling banks, each of which is a separate corporation with its own balance sheet, and transactions must be settled among these banks. For this purpose, the Federal Reserve Board maintains interdistrict settlement accounts for the Federal Reserve Banks. This account appears on each Federal Reserve Bank's balance sheet. Each transaction between Federal Reserve Banks results in a credit to the interdistrict settlement account of one Federal Reserve Bank and a corresponding debit to the other's. As a result of the accumulated debits and credits, each Federal Reserve Bank has an accumulated position that is either a debit or a credit, and on the consolidated balance sheet of all 12 Federal Reserve Banks, these debits and credits net to zero. Once each year the interdistrict settlement account of each Federal Reserve Bank is brought to zero by the reallocation of the Federal Reserve Bank's ownership interest in the System Open Market Account—the consolidated holdings of all Federal Reserve Banks' government securities.
One disadvantage of Fedwire is that all participants in the system in good standing can incur a large daylight overdraft position. Banks incurring such overdrafts are charged a fee by the Federal Reserve.
2. CHIPS
In contrast, CHIPS is a true real-time final settlement system. As explained above, the release of a payment message creates an obligation to pay the amount of the payment order that is settled in accordance with the system and method described in U.S. Pat. No. 6,076,074.
An earlier version of CHIPS involved an end-of-day, multilateral net settlement system. At the end of each day, each participant received a report showing the total value of all payment messages sent, the total value of all payment messages received, and a net figure (debit or credit) showing the difference. Once the agreement to settle on the basis of the report has been received from each settling participant, the Clearing House would instruct the Federal Reserve Bank of New York to open the CHIPS settlement account that it held on behalf of all CHIPS settling participants and send a notice to all settling participants that settlement could begin. After this notice had been sent, each settling participant that had an aggregate net debit position had 15 minutes to send a Fedwire funds transfer in the amount of its debit position to the CHIPS settlement account at the Federal Reserve Bank of New York (FRBNY). Once all these Fedwires were completed, the Clearing House checked the balance in the account and then sent Fedwire payment orders from the settlement account to the accounts of those settling participants that were in a net credit position. Once all of these Fedwire payment orders had been sent, settlement was complete, and all CHIPS payments made that day were finally paid.
This type of multilateral net settlement system, which provides for settlement at the end of the day, is subject to the risk that a participant with a net debit position (a “debtor participant”) would be unwilling or unable to pay its settlement obligation. Absent some measures to make up for the debtor participant's failure, a failure of this kind could mean that the system would fail to settle, which could mean that the finds transfers that were processed by the netting system on the date of the failure would not be completed. Depending on the number and value of the payments handled by the funds-transfer system, such a failure could have serious deleterious effects on the surviving participants and world financial markets generally.
CHIPS took a number of steps to control the risk of a settlement failure. In 1984, it required each of its participants to establish “bilateral credit limits” on each other participant as a measure of the credit risk that it would be willing to accept from the other participant. In 1986, CHIPS took a further step by establishing “sender net debit caps” on each participant as a percentage of the aggregate of the bilateral limits that had been established by other participants. This control limits the amount of risk that a participant can present to the system.
In 1990 CHIPS took the further step of requiring each of its participants to agree to pay a portion of a failed participant's settlement obligation. This “additional settlement obligation” is collateralized by Treasury securities pledged for this purpose and held at FRBNY. This collateralized loss-sharing arrangement assured that CHIPS would be able to settle even if the participant with the highest debit cap were to fail at its greatest possible debit position. (Called the “Lamfalussy Standard” because it was articulated by a working group of the Bank for International Settlements chaired by Alexandre Lamfalussy. CHIPS had in fact anticipated the Lamfalussy Standard and had adopted this risk-control measure before the BIS report had been issued.)
In 1994, CHIPS began to strengthen its existing risk controls so that by 1997 the two banks with the highest debit caps would fail simultaneously with each at its greatest possible debit position, and CHIPS would still be able to settle (referred to as a “Lamfalussy+1 Standard”). The same loss-sharing formula would allow CHIPS to settle if a large number of smaller banks were to fail.
Despite these measures, there remained the risk that a catastrophic financial crisis could result in a settlement failure on CHIPS with the result that all of the payment messages released would have to be “unwound”; i.e., all payment messages be pulled back from the receiving participant and returned to the sending participant, who would be free to decide whether or not the payment should be sent.
To address this risk, CHIPS introduced a system in January 2001 that continuously matches, nets, and releases payment messages on an individual, bilateral, or multilateral basis among participants throughout the day. This system requires each participant to deposit a predetermined amount into a prefunded balance account. Payment messages are not released unless (a) the value of the payment message can be simultaneously charged against and credited to prefunded balances established by each participant; or (b) the payment message can be netted and set off against one or more other payment messages and the resulting balance simultaneously charged against and credited to prefunded balances established by each participant. However, participants are not allowed to make additional deposits to or withdrawals from the prefunded balance account until the system closes for receipt of payment messages at the end of the day. This system greatly reduced the risk of settlement failure due to failure by one or more participants during the business day.
3. German EAF 2 System
A third type of system, which uses elements of both the gross settlement and net settlement systems, is the Electronic Clearing Frankfurt (EAF 2) system, operated in Frankfurt by the Deutsches Bundesbank, the central bank of Germany.
EAF 2's operating day has two phases. In phase 1 (8:00 a.m. to 12:45 p.m.), payment orders received from financial institutions are entered into the system and offset bilaterally, and final payments are available to the recipient credit institution at regular intervals of approximately 20 minutes. These payments are settled as they would be in a gross settlement system. The proceeds of the payment order can thereafter be made available to the beneficiary without credit risk to the receiving bank. In a subsequent phase 2 (1:00 p.m. to 2:15 p.m.), an attempt is made to effect two-stage multilateral clearing of the remaining payments, which have not been netted bilaterally during the first phase. The crucial difference from multilateral clearing, as it exists at present, lies in the avoidance of the systemic risk. If there are uncovered debit balances, no unwinding, involving the exclusion of a participant and the return of all payments associated with the excluded participant, takes place; instead, only individual payments are returned. These individual payments are treated as uncovered payments, as in a gross settlement system.
In phase 1, EAF 2 is very similar to a gross settlement system in which individual payments are executed after cover is available. It is based on the principle that, in bilateral relations, incoming payments are used preferably instead of account balances as cover for outgoing payments, by offsetting them against each other in 20-minute cycles, at which point they become final. The use of liquid funds as working balances, in the form of account balances, is necessary only to a limited extent, compared with a purely gross settlement system, in that the amounts of counter-payments included in the offsetting procedure do not match exactly. In EAF 2, in contrast to a net settlement system, incoming and outgoing payments, which are matched as far as possible, in terms of their amount, are offset against each other. The payments not included in the offsetting procedure are then carried over into queues for the next processing cycle. By contrast, in a net settlement system, a net balance is calculated as the difference between all incoming and outgoing payments, which is settled by debits or credits to an account at the end of day.
In EAF 2 the participants themselves determine how much liquidity or working balances in the form of so-called maximum sender amounts they wish to make available to clear residual differences between the payments included in the offsetting in the particular bilateral relation concerned. In this way, they limit the extent to which they are willing to resort to their own funds, in excess of those received from the counter party. These maximum sender amounts are covered by the transfer of liquidity to a special account of a participant, whose credit balance has been assigned to the bilateral party concerned. Apart from that, the system takes advantage of the high level of two-way payments to conserve liquidity. At the end of phase 1, in order to simplify accounting, all bilateral debit balances of each participant are aggregated into a single overall credit balance, and both overall balances are booked on the giro accounts (a type of German draft account) and the assigned amounts released.
At the beginning of phase 2 (about 1.00 p.m.), there is an initial multilateral clearing process of the payments not settled in phase 1. If debit balances are not covered, the maximum volume of residual payments, which is covered by liquidity on the giro accounts, is calculated on the basis of an algorithm for sorting out individual payments. These residual payments then become final immediately. With the aid of the objective selection criteria predefined by the algorithm, individual payments that have caused the uncovered debit balances are identified. The individual payments that are regarded as uncovered are set aside provisionally pending the execution of the second multilateral clearing, and the revised balances are booked on the Bundesbank giro accounts.
Subsequently, the participants are granted a 45-minute period to acquire cover. Technically, this can be obtained in two different ways: (i) a payment input from the EIL-ZV (the gross settlement system of the Bundesbank) increases the account balance, which is then used to cover the net balances; or (ii) a payment input in the EAF 2 itself (in favor of participants with debit balances) changes the net balances between the participants; the liquidity on the giro accounts remain unchanged.
If net balances arising from the subsequent second multilateral clearing are still uncovered, no unwinding, involving the exclusion of a participant, is performed. Instead, by means of the above-mentioned algorithm, individual payments are now finally withdrawn until the covering funds on the giro accounts are sufficient. Thus the EAF 2 clearing and settlement is always completed, and the systemic risk typical of net settlement procedures is avoided by ruling out an unwinding of a high volume of payments. The individual payments that are treated as uncovered are deemed to be revoked and are not executed. The finality of the payments offset bilaterally in phase 1 and cleared and settled multilaterally in phase 2 is not affected by this. This procedure is also the same as that used in a gross settlement system, where uncovered payments remaining in queues are returned without affecting the finality of payments that have already been executed. Payments that have not been executed can be either entered on the same day into a gross settlement system, such as the German EIL-ZV system, whose operating hours may be extended slightly for this reason, or re-entered in EAF 2 the following day.
The EAF 2 system has several drawbacks. For one thing, although final settlement occurs throughout the day, the occurrences are at 20 minute intervals. Also, although the system allows prefunded accounts to be set up by individual institutions, each account is created for use in offsetting payments to a preselected financial institution. For example, Bank A may set up an account for offsetting payments and receipts vis-à-vis Bank B, and only Bank B, and another account for Bank A's relations with Bank C, and so on.
By contrast, CHIPS provides continuous intraday final settlement of payments by means of prefunded accounts of participating financial institutions that are used to offset payments and receipts as against all other participants. Under the CHIPS rules, each participant is required to deposit a predetermined amount into the prefunded balance account. This deposit is recorded on CHIPS's books as the participant's “opening position” or “initial prefunded balance.” As each payment message is released (whether individually or in bilateral or multilateral batches), the amount of the payment message is subtracted from the position of the sending participant and added to the position of the receiving participant. The intraday record of each participant's opening position, adjusted to reflect these increases and decreases, is referred to as its “current position.” Participants are not permitted to make additional deposits to or withdrawals from the prefunded balance account during the day until the system has closed for receipt of payment messages.
The release of payment messages is controlled by a computer program (the “balanced release algorithm”) to ensure that no participant's current position is ever less than zero or more than twice its opening position. These boundaries require some payment messages, especially higher value payment messages, to be held in a queue, because they could not be released without causing either the sending participant's or the receiving participant's current position to fall outside of their current-position boundaries. Nevertheless, the balanced release algorithm is extraordinarily efficient.
Still, the experience has been that a few very large payment messages may be held by the balanced release algorithm for 30 minutes or more, and that these delays can be of concern to participants and their customers. In addition, the operation of the balanced release algorithm does not clear all payment messages before the end-of-day close, requiring a final prefunding phase to settle and release any payment messages that remain unreleased.
Given this background, what is needed is a system and method for allowing banks to supplement their prefunded balance account with intraday supplemental funding. This supplemental funding would permit banks to allow large payment messages to be processed quickly, which in turn should reduce the size of the final prefunding requirements at the end of the day.